Brexit would trigger prolonged uncertainty, EU import tariffs

A decision for the UK to exit the European Union ('Brexit') would result in prolonged uncertainty and would be credit negative for UK-based companies such as the car, manufacturing, food and beverage, and service sectors, Moody's Investors Service said Monday. Many companies would likely curb investments until the implications of a Brexit become clear for trade, investment, regulations and labour costs were clear while the UK’s Aa1 credit rating would be at risk. There would also likely be EU tariffs on some imports to the EU until final permanent arrangements were negotiated.

The ratings agency said that it could take two or more years for the UK to formally exit the Treaty on European Union, during which time Moody's expects that negotiations would progress towards alternate agreements. This period would also allow companies some time to adapt to a post-Brexit operating environment.

Our central view is that both the UK and EU would want to avoid an unnecessary large-scale disruption to trade and capital flows, given their deep economic and financial ties. However, it is unlikely that current arrangements would be replicated in full, particularly if the UK seeks to limit EU citizens’ ability to live and work in the UK. There may also be some political pressure to limit the UK’s access to the single market, in order to discourage other member states from following the UK precedent. This would imply somewhat weaker economic growth in the UK; and, as such, the new status quo may also result in a lower sterling exchange rate, which could help to rebalance the economy. However, any persistent decline in the exchange rate would probably be smaller than the 25% depreciation seen in 2007-08. Nor would we expect an immediate increase in UK policy rates in response; much like the 2007-08 period, we believe that policymakers would look through the ‘relative price’ effect of temporarily higher inflation.

"The biggest near-term credit risk from a Brexit for companies is the uncertainty that would follow with regards to trading relations, industry regulations and labour mobility. We expect that some companies would curb investments until there is greater clarity in these areas. However, given the potential two year timeline for a Brexit to take effect, there is likely to only be a few, if any, near-term rating changes," said Richard Morawetz, a Moody's Group Credit Officer for the Corporate Finance Group and lead author of the report.

In the longer-term, rating changes could be more pronounced if a Brexit became clearly detrimental to trade, investment or labour costs, and ultimately to companies' profitability.

However, Morawetz added that considering the substantial trade links that exist, there would be strong incentives for both the UK and EU to minimise the effect.

Barring new agreements, EU import tariffs would apply for many UK-based companies post-Brexit, such as a 10% tariff for cars, which would be relevant for companies like Jaguar Land Rover Automotive Plc (Ba2 positive) and Aston Martin holdings (UK) Limited (B3 stable). The supply chains of manufacturing companies that import from the EU could also be affected by any new tariff or non-tariff barriers.

Moody's says regulatory changes would be significant, but could either be positive or negative in certain sectors where UK regulations are confined by EU directives that require significant investment in water, telecoms and energy infrastructure. For example, in the telecoms sector the EU agreement in June last year to scrap roaming charges for travelers in the EU by 2017 would not automatically apply in the UK if it voted to leave. Although some UK operators, like Vodafone Group Plc (Baa1 stable), have already scrapped the charges.

Any curbs on future labour mobility would affect sectors with the highest share of foreign-born workers, notably food production, business services and retail. However, in the case of retail, the government's introduction of a higher living wage through to 2020 could have a greater effect on wages than a Brexit.

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Gideon Rachman, chief foreign affairs columnist, tells Frederick Studemann, comment and analysis editor, why he believes the chances of a vote to leave the EU in June’s referendum are growing.